Both the FTSE 100 index and America’s Dow Jones Industrial Average seem to be bouncing higher today, as I write. It we’ve no way of knowing whether the high volatility will continue in the markets, or whether this is the start of a climb back up.
In the meantime, we do know that many share prices are well off their highs, and I reckon it’s a good time right now to search for good value with individual shares. In the FTSE 100, Lloyds Banking Group (LSE: LLOY) and pharmaceutical provider AstraZeneca (LSE: AZN) have caught my eye, but which one should I buy? I reckon the comparison is interesting because the firms reside at opposite ends of the cyclical/defensive spectrum, with Lloyds being an out-and-out cyclical operation and AstraZeneca being one of those firms we like to think of as being defensive.
Cheap for a reason
Lloyds share price is down around 20% since the beginning of the year, and AstraZeneca’s is about 14% higher over the same period. At first glance, Lloyds is selling cheap. The recent share price of 58p throws up a forward price-to-earnings (P/E) multiple of just below eight for 2019, and the forward dividend yield runs a little over 6%. Meanwhile, AstraZeneca’s recent share price close to 5,900p puts the firm on a forward multiple of nearly 21 times forward earnings for 2019, and the forward dividend yield runs near 3.7%.
If you were just looking at raw valuations and searching for high dividend yields, you’d probably go for Lloyds. However, I think the bank deserves its low valuation because of its cyclicality. Profits have been high for some time, but City analysts following the firm expect a flat outcome on earnings growth for 2019. This suggests the firm is trading close to peak earnings in the current economic cycle. With earnings so high, I don’t think we’ll see an upward valuation re-rating soon. I reckon the stock market has been reducing the firm’s valuation for several years in anticipation of the next economic downturn, which will probably lead to falling profits at Lloyds.
I think AstraZeneca’s higher valuation reflects the firm’s steadier forward prospects. City analysts expect earnings to decline 23% this year, and to bounce back 11% or so in 2019. The business is in the process of rebuilding earnings by developing products from its research and development pipeline. That comes after several years of declining earnings because previous big-sellers timed out of their patent protection.
However, the underlying dynamic that I like with AstraZeneca is that its customers tend to keep spending on their medicines whatever the economic weather. The story at Lloyds is different. If the economy falters, so will Lloyds’ business.
I think the two companies’ records on operational cash flow helps to show the difference between them. Lloyds is patchy, with as many negative years as positive ones. AstraZeneca’s is much steadier. Over the last few years, the cash flow has always been a positive figure and big enough to support the earnings that the firm delivered.
With Lloyds, I’d always be wondering when the next cyclical crash in the share price will arrive, if I held, but with AstraZeneca, I’d be happy to buy the shares and tuck them away for 20 years. So, I choose AstraZeneca.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended AstraZeneca and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.